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Briefing note for Section 58 victims to send to MPs

The following briefing note has been prepared for IT contractors and other victims of Section 58 to send to their MPs.

Compiled by No To Retro Tax (NTRT), the note is a response to statements that Exchequer Secretary David Gauke, the minister responsible for tax, has made to MPs about Section 58 of the Finance Act (2008) which, for imposing tax retrospectively, spells bankruptcy for thousands of individual contractors, despite them following the law as it stood at the time.

Mr Gauke has said: “The tax arrangements used were described by the courts as a tax avoidance scheme that was wholly artificial. The scheme in question involved artificially routing, through Isle of Man trusts and partnerships, incoming arising in the UK to UK residents, and had no commercial justification. The intended outcome was to allow the user to reduce their effective UK income tax rate to a much lower rate than the normal statutory rate, resulting in a substantial loss to the Exchequer.”

NTRT: We would challenge this description, since the schemes had a real and clear benefit in giving certainty to contractors about their tax position following the introduction of the deeply flawed IR35 legislation, and was heavily marketed for these purposes. Many contractors were left in an impossible situation by the IR35 rules and would never have needed to use tax planning schemes had IR35 been properly drafted. Indeed, these concerns have since been recognised with the Office for Tax Simplification recommending that IR35 should be suspended and the Treasury announcing its intentions to simplify its administration.

Regardless of this, and despite the recent media attention given to the issue of tax avoidance in recent weeks, legitimate tax planning and tax avoidance is not illegal provided it is open, transparent and declared to HMRC, as were the schemes affected by Section 58.

If HMRC believed the schemes were illegal, they could have either challenged them in the tax courts or closed them down prospectively. Again, this was acknowledged by Mr Gauke when the legislation was passed in 2008, and he argued that there was no need for retrospection since, if the schemes really were illegal, all that was needed was for HMRC to litigate against users.

Mr Gauke has said: “NTRT has referred to 3,000 people being affected by the legislation. I understand from HMRC that although at least 3,000 individuals set up the foreign trusts needed for the scheme, more than one-third of these were never used. HMRC have identified around 1,900 individuals who have used the scheme and whose tax returns are under enquiry.”

NTRT: We are happy to work on the premise that only 1,900 people are affected, but again we would question whether this is accurate. In evidence to the High Court in December 2009, David MacDougall of HMRC Special Investigations quoted 2,500 individuals, a number which he said he expected to rise.

In answer to a Parliamentary Question in November 2009, Stephen Timms MP, then a Treasury Minister, said 3,000 people were affected, and so this is the figure we have used.

Regardless of whether the true number is 1900, 2500, 3000 or more, the point remains that a very large number of people have been affected by this draconian legislation and stand to lose their homes and livelihoods as a result of Section 58, and, as evidenced by the large number of representations he will have received from constituents affected by this issue, as a Minister it is Mr Gauke’s duty to address their concerns.

Mr Gauke has said: “HMRC made it consistently clear throughout that it considered the schemes did not work, and regularly recommended that payments be made on account.”

NTRT: This is simply untrue. HMRC were first aware that that these schemes were possible in 1987. That they published the scheme in their international tax manual in 1993 and on their website shows that they were aware they could be used, and, while inclusion in the tax manual does not necessarily indicate acceptance, the manual did only state that they would be kept under review.

The fact they were tolerated for so long led most reasonable and logical people to conclude that HMRC had decided to accept them. This view was expressed by the Chancellor of the Exchequer George Osborne MP, who on March 20th 2009 wrote that it created “legitimate expectation amongst taxpayers that the practice would be tolerated”.

The first time that HMRC communicated its view that the schemes did not work, according to the Parker LJ judgement in the High Court, was in February 2006. However, the majority of scheme users did not receive any notification of this view until May 2007. Our understanding is that the scheme promoter then immediately informed HMRC of the legal grounds why they believed the scheme worked. HMRC did not respond to this letter.

Although HMRC said that it intended to take some test cases to the tax courts, it never went ahead with these, again giving the impression of tacit acceptance that the schemes did in fact work.

While it may be the case that internally HMRC considered they did not like the scheme, this is not the same as communicating that it didn’t work, giving reasons as to why it didn’t work, or taking any action, and as demonstrated by Technical Exchange 63, a range of options to challenge them in the tax courts were deemed unlikely to succeed because the scheme was legal at the time.

Therefore, the earliest it can be claimed that users were notified of HMRC’s view that the scheme didn’t work was in February 2006, or May 2007. Even then, this is not definitive because HMRC did not appear to have any faith in the arguments they had put forward; did not move to challenge the schemes in the tax courts, and although it opened some inquiries, inquiries are opened every day for a number of reasons and do not necessarily mean that there is anything untoward – indeed, some tax inquiries even lead to a rebate.

Moreover, far from making it clear that the schemes did not work, we are aware of several cases where HMRC accepted money claims for tax relief under the schemes, and have documentary evidence to show this was the case. From a very small sample, we are aware of seven claims that were accepted, and one of these had a claim for £43,000 included for the tax year 2003-4. By accepting this claim, HMRC thus conceded a five figure sum in tax and national insurance, and it was this acceptance of the scheme’s validity by HMRC that led many others to sign up. This is an extremely serious point since it shows that HMRC accepted the validity of the schemes in some instances, creating realistic expectation amongst other users and of course scheme promoters. At the time these claims were accepted, HMRC were aware of over 1,400 other potential claims. This disproves the assertion that users were warned throughout that the schemes didn’t work.

Finally, Mr Gauke’s statement that victims of Section 58 were warned throughout that the schemes didn’t work is at odds with the reasons given to Parliament for implementing the legislation retrospectively. During discussion on the retrospective application of the legislation in committee stage, Jane Kennedy MP, then the Financial Secretary, stated that it was needed because “HMRC has not consistently made the case throughout the time period that the scheme does not work.”

Mr Gauke has said: “It has always been HMRC’s view that the scheme did not work on the basis of existing law. The change introduced by Section 58 was a retrospective clarification to put this beyond doubt.”

NTRT: If the scheme did not work on the basis of legislation as it stood before 2008, then why was a retrospective change to the law needed to ‘clarify’ the position? HMRC could have dealt with the matter at the time by either challenging the schemes in the tax courts, or if the law was not as intended, it could have legislated to shut them down prospectively. If the law was as HMRC says, why did they not simply litigate? These are not our words – this is the exact argument used by Mr Gauke when he was Shadow Exchequer Secretary in 2008 and when he argued vociferously against Section 58.

The Government argued at the time that Section 58 clarified an existing piece of retrospective legislation – Section 62(2) of the Finance Act 1987, known as Padmore. However, the nature of the retrospection differed substantially between Padmore and Section 58. Padmore did not retrospectively tax anyone, or generate demands for payments that were not due at the time the schemes were in operation, whereas the retrospective application of Section 58 generated new tax demands of thousands of pounds.

A further argument that HMRC depended on was that the Padmore debate mentioned that the Padmore legislation would have a “wider meaning”. In 1987 this referred to a wider class of double taxation agreements – i.e. that it would affect the Jersey DTA, and IoM DTA and a few others that did not have an anti-avoidance purpose. In 2008, however, HMRC portrayed the ‘wider meaning’ to refer to the words ‘member of a firm’. This was a complete adulteration of the facts.

By implementing Section 58 retrospectively, rather than allowing the courts to interpret the law, HMRC indicated that it is willing to re-write history so legislation says whatever they wish it had said at the time. Such an approach gives individuals and businesses no reassurance that the law is what they think it is, as it is written down and passed by Parliament.

Section 58 did not ‘clarify’ Padmore – it changed it retrospectively to bring it in line with HMRC’s interpretation, which is something wholly different to the law as it stood at the time. In doing so, it denied victims of Section 58 the right to defend their actions under the law as it stood when they were carried out.

Mr Gauke has said: “Users of the scheme were advised by the promoter, before an announcement of the changes introduced by Section 58, that while the promoter had taken legal advice, no guarantee of the outcome of a challenge by HMC could be given.”

NTRT: Such a warning is standard practice for any tax planning scheme. Users of this particular scheme were perfectly willing to accept the outcome of any legal challenge by HMRC – but the fact is that rather than go ahead with such a challenge under the law as it stood, Section 58 retrospectively changed the legislation, meaning that people using the scheme could no longer defend their action under the law as it stood at the time. This is a denial of natural justice and could not have been reasonably foreseen by any promoter or user of the scheme.

Mr Gauke has said: “In two judicial reviews, the courts have found that the retrospective element of the legislation is proportionate and compatible with the European Convention on Human Rights. The Government accepts the courts’ verdict that the changes were both a proportionate and legal response to the tax avoidance undertaken.”

NTRT: This is untrue. The court case only challenged the validity of the legislation under European human rights law and whether Parliament had the right to act retrospectively. Our concerns relate to the impact of the legislation, not its acceptability under human rights law, and the fact that MPs did not appear to have been furnished with all the facts by HMRC when recommending that Section 58 be applied retrospectively. During the hearing mentioned above, the court was not permitted to examine Hansard and did not consider the difference between Padmore and Section 58. The court had no remit to rule on these issues, which are entirely policy matters to be considered by MPs and Ministers.

Mr Gauke has said: “Section 58 is proportionate and a reasonable response to a wholly artificial tax avoidance scheme.”

NTRT: The justification for applying Section 58 rests on the assertion that HMRC consistently maintained that the schemes did not work, that they never accepted the schemes worked, and accepted no claims for relief under the schemes. We have shown that this is untrue. It has also been justified through the assertion that it clarified the Padmore legislation. However, as we have shown, there were substantial differences which make retrospective taxation an excessive method of ‘clarifying’ HMRC’s belief that Padmore applied in the case of these schemes.

It is therefore clear that from a public policy perspective, it is not reasonable or proportionate that Section 58 was applied retrospectively:

- HMRC knew about the scheme for decades.

- HMRC knew it was in active use from the late 1990s.

- HMRC accepted five figure tax relief claims under the scheme.

- HMRC did not notify users until 2006 that it considered that it didn’t work.

- If the scheme really wasn’t effective, HMRC would have simply taken the matter to the commissioners/tax courts just as they do with others, but they chose not to do so.

- Padmore gave the message that tax planning would be allowed to succeed if it worked.

- HMRC have mischaracterised Padmore.

- HMRC have accepted claims in the name of the head of the investigation (A Barnett) in March 2006.

- HMRC offered to settle all claims on the basis of four test cases, but didn’t take these cases forward.

- HMRC broke their protocols and Parliamentary Rees Rules by not giving a clear signal to act retrospectively in this case.

- HMRC never signalled that retrospection would be used in this instance. In fact, HMRC have since acknowledged that the first time retrospection had been considered internally was November 2007, just a few months before the legislation was passed in Parliament.

On this basis, we believe there is an urgent need for the Exchequer Secretary to meet with the No to Retro Tax campaign to discuss these issues and find a potential solution for the thousands of victims of this iniquitous and draconian legislation.